Pound-Canadian Dollar Rate Forecasts Upgraded at Lloyds

- Pound, Dollar both forecast to fall from current highs against CAD.

- Greatest risk is a breakdown in the Canada-US trade relationship.

- Canadian Dollar could "depreciate substantially" if NAFTA disintegrates.

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The Canadian Dollar is set to recover lost ground against the Pound and US Dollar in 2018 if the Canada-US trade relationship avoids a further deterioration, according to the latest forecasts from Lloyds Bank, one of the UK's most recognised high street lenders.

This would market a reprieve from a continuation of the relentless selling pressure that has pushed Canada’s currency to an 18 month low against the Pound and to a 7 month low relative to the Dollar this far in 2018.

“Strong US economic data, including evidence that the labour market is approaching full employment, has induced the market to move closer to ‘pricing-in’ three interest rate rises from the FOMC this year. This has supported the USD,” says Gajan Mahadevan, a strategist at Lloyds. “Across the border, disappointing Q4 GDP growth has tempered the Canadian interest rate outlook. Nevertheless,the market still expects the BoC to tighten by at least a further 25bps in 2018.”

Divergent economic momentum and interest rate expectations may have been factors that contributed to the Canadian Dollar’s ongoing weakness.

However, the real drivers of the first-quarter rout have been concerns over the future of the NAFTA, which were on full view again Thursday, and a sudden escalation in protectionist actions toward the rest of the world from the White House.

The North American Free Trade Agreement, which President Trump described as “the worst deal in history” when on the campaign trail, is in the midst of being renegotiated. The White House has threatened to withdraw from the pact in the absence of more palatable terms.

“Of most importance to USD/CAD, however, is the future of the trading relationship between the US and Canada. The threat of the US withdrawing from NAFTA has driven the pair higher. Were this ‘outlier’ event to occur, the CAD would likely depreciate substantially,” Mahadevan adds.

Canada caught a lucky break earlier in March when President Donald Trump exempted the country, as well as Mexico, from new tariffs of 10% and 25% respectively that the White House imposed on imports of aluminium and steel into America.

Including Canada in the tariff order would have been damaging for the country’s economy given that the US is its largest export market for metals, with approximately $12 billion of steel being shipped south of the border annually.

However, the reprieve may prove short-lived as Canadian Prime Minister Justin Trudeau is reported to have said Tuesday that Canada could be forced to replicate President Trump’s tariffs on imports from the wider world.

This would be in order to ensure the country is not used as a conduit into the US for foreign steel producers seeking to evade the White House’s new levies.

Moreover, trade tensions appeared to resurface Thursday when President Donald Trump wrote on Twitter that Canada does run a trade deficit with the US, despite the Office of the U.S. Trade Representative saying America runs a $12.5 billion goods and services surplus with Canada.

Trade surplus countries and supranational blocks such as the European Union have been frequent targets of outbursts from the US President.

Earlier in March, the White House threatened to impose tariffs on European carmakers’ imports into the US if the EU retaliates against its steel and aluminium levies.

“With President Trump providing Canada with an ‘exemption’ from tariffs on steel and aluminium, hopes remain that an amicable deal can be reached,” Mahadevan says, referring to the NAFTA accord.

Mahadevan and the Lloyds team say a NAFTA breakdown would be an “outlier event” and is not what they expect to happen.

“Assuming no significant deterioration in North American trade, we forecast USD/CAD to fall to 1.24 by year-end,” the strategist writes, in Lloyds’ latest International Financial Outlook.

Mahadevan and the Lloyds team forecast the USD/CAD rate will fall to 1.24 by year end, which is nearly 5% below the 1.3035 level seen Thursday, while equally steep losses are predicted for the Pound-to-Canadian-Dollar rate.

Lloyds forecasts the Pound will fall from 1.8232 Thursday to 1.71 before the 2018 year is out as trade concerns melt away and markets return their focus to relative interest rates. This implies a 6% decline for the GBP/CAD rate over the coming months.

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